Intermediation Frictions in Equity Markets

Abstract

Stocks with similar characteristics but different levels of ownership by financial institutions have returns and risk premia that comove very differently with shocks to the risk-bearing capacity of financial intermediaries. After accounting for observable stock characteristics, excess returns on more intermediated stocks have higher betas on contemporaneous shocks to intermediary willingness to take risk and are more predictable by state variables that proxy for intermediary health. Intermediary risk-bearing capacity also explains a substantial and increasing fraction of the variation in conditional risk premia for portfolios sorted on intermediation. The empirical evidence supports the predictions of asset pricing models featuring financial intermediaries as marginal investors who face frictions that induce changes in their risk-bearing capacity. This suggests that such models are useful for explaining price movements not only in markets for complex financial assets, but also within asset classes where households face comparatively low barriers to direct participation.